ILS’ role in paying climate related catastrophe claims to increase: Moody’s

The role of insurance-linked securities (ILS) and alternative reinsurance capital in paying catastrophe claims related to climate change is set to increase, as the insurance and reinsurance sector becomes increasingly aware of the climate risk it faces and turns to efficient capacity to help it offset them.

The rating agency says that Environment, Social and Governance (ESG) issues are likely to increasingly be integrated into the business strategies of insurance and reinsurance firms, with this also presenting some opportunities as the awareness and visibility of the climate related risks being underwritten grows.

One area that stands to benefit as climate change related risks increase in re/insurance is the ILS market and capital market investors, given a greater proportion of premiums and as a result claims are likely to be ceded the way of third-party capital.

“A rise in catastrophe claims due to climate change will also likely result in an increased role for alternative reinsurance capital in absorbing catastrophe losses,” Moody’s analysts explained.

50% of re/insurance companies responding to a survey undertaken by Moody’s said that they expect the role of alternative capital in managing the impact of climate-related weather events will increase in some way, while the other 50% of those surveyed said that alternative capital will continue to play the same role it does today and won’t become more important due to climate change.

Some 20% of those who believed a greater role is ahead for ILS and alternative capital cited the expectation that there will be an increasing need for reinsurance firms to use a growing amount of ILS capacity, largely in terms of retrocession, as they look to limit their exposure to peak risks and increased uncertainty caused by climate change.

The larger share (30%) of respondents said that they expect primary insurers will also seek out more collateralized reinsurance capacity, to help them limit their peak risk exposure and reduce climate related uncertainty.

So that 50% all believe that ILS and alternative capital will grow its market share to help re/insurers manage their peak exposures better and to help them reduce their climate related exposures as well.

Moody’s notes that the use of alternative capital can, “Help (re)insurers to maintain coverage of risks that might otherwise become uninsurable under certain climate change scenarios.”

Additionally Moody’s expects, “(Re)insurers in partnership with alternative capital and governments, could become significant players in developing risk solutions to address social needs arising from key ESG factors, such as climate change and population aging.”

Given the ILS fund specialists focus on and ability to underwrite catastrophe exposures and weather risks, the market is the perfect partner for re/insurers looking to reduce the volatility in their results due to expected climate risk frequency and severity increases.

The ILS market is also the ideal partner to help re/insurers maintain a stake in markets where the levels of ESG related risk are too high for their balance-sheets to bear, but where their expertise can allow them to earn fee income by underwriting on behalf of alternative capital investors.

The ILS market and its institutional investors has a growing role to play in re/insurance anyway, but the implications of climate risk suggest that role could increase more rapidly than had been anticipated, suggesting market share in catastrophe and weather risks will inevitably flow the capital markets way.

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